Progressive Views on the News

The Rajan Theory: Rising Inequality the Root Cause of the Great Recession

As noted by The Economist, “[s]everal prominent economists now reckon that inequality was a root cause of the financial crisis.” Indeed, in recent years there has been a proliferation of analyses supporting this view writes Till van Treeck in Did inequality cause the U.S. financial crisis? published on boeckler.de.

The explanation is straightforward: As the benefits of rising aggregate income over the past decades were confined to a rather small group of households at the top of the income distribution, the consumption of the lower and middle income groups was largely financed through rising credit rather than rising incomes.

This process was facilitated by government action, both directly through credit promotion policies and indirectly through the deregulation of the financial sector. But with the downturn in the housing market and the sub-prime mortgage crisis starting in 2007, the overindebtedness of the U.S. personal sector became apparent and the debt-financed private…